Everything You Need to Know About Startup Funding
Being your own boss and making the world a better place are indeed wonderful and noble ideas. However, once you’ve maxed out your credit cards and spent all the money you’ve kept hidden away for a rainy day to fund your passion project, the next best thing since sliced bread can quickly turn into a complete disaster.
So, if you’ve put your entrepreneurial skills to the test and decided to ditch your 9-5 to start something great - or if you’re thinking about it - you need to get familiar with your funding options. There are plenty of opportunities for startup funding; we’ll explain each in detail so you know what to focus on when you’re looking.
How Do You Get the Required Funds?
On the one hand, you have startups and their founders or initial teams who are looking to get the funding they need. On the other hand, there are investors. Most companies go through several phases while asking for funding: from pre-seed, usually lent by friends and family, to seed, then on to series A, B, and ultimately C if they’re successful.
Now, there are plenty of doors you can knock on to get funding for a startup, and there are plenty of different types of funding, too. The most common solutions are venture capitalists (VCs) and angel investors - think Shark Tank, but less scary. Many startups also rely on alternative financing methods, such as crowdfunding, crowdinvesting, or even opting for an ICO if the business can benefit from incorporating blockchain into its processes.
Of course, every investor wants to make a profit on their investment, and this is where equity comes into play. Typically, most investment arrangements are drafted so that the investor gets partial ownership of the company in exchange for their money. Once the company starts growing and turning a profit, the investor typically gets rewarded based on the amount they’ve invested and the equity they hold.
Before any money moves in the startup funding process, companies looking for funding must undergo valuation. Valuation is based on various factors, such as track record, market size, and most importantly the level of risk involved. The valuation typically changes as the funding rounds change, or, more precisely, as the business grows.
When you think of funding, VCs and angel investors are probably the first thing to pop into your head. However, these are just two of the many available funding options; we’ll discuss the eight most common ones in this article.
The numbers are precise on the topic of “how to get funding for a startup;” out of the $531 billion startups raise each year, $185.5 billion comes from the entrepreneur’s own pocket. Over $60 billion is usually provided by friends and family, and venture capitalists and angel investors raise about $42 billion together. Banks provide around $14 billion, while crowdfunders support their favorite projects with approximately $5.1 billion annually.
Now let’s discuss these options in a bit more detail to help you find the one that’s most appropriate for your business.
Friends and Family
The first step is invariably digging deep into your own pockets to fund your idea and turn it into a profitable business. However, not everyone has pockets deep enough to accomplish funding a startup small business by themselves. So, the next logical step would be to turn to your family and friends to help you with initial expenses.
This round of funding, because it is usually informal, is commonly known as pre-seed funding. Oftentimes it’s not even considered a seed round at all. Investors in this round usually don’t take equity in return, and the money “borrowed” rather than invested.
While this option can be tempting initially, you shouldn’t take it lightly. Of course, it’s an excellent way to find funding for startup businesses without worrying about equity, interest rates, or any legal hassle. But if you do borrow from your friends and family, make sure you’ll be able to pay it back in the future. If not, you could seriously damage some relationships.
Still, this is perfect if your business has potential but lacks the funds required to get started. Try not to borrow more than you can genuinely repay, and double-check whether your business actually needs an investment of that size or whether it could benefit from a reevaluation.
When one thinks of startup funding, usually the first thing that comes to mind is VC funding. This type of funding usually involves well-off investors, financial institutions, and banks. However, baby companies rarely qualify for VC funding immediately; instead, this money usually goes to businesses with a positive track record or incredible growth potential.
Occasionally, new businesses can take advantage of the fact VC funding is not exclusively monetary. Sometimes, experienced businesspeople are willing to offer their knowledge and experience in exchange for equity. In specific situations, this can be much more valuable than getting funding for a startup.
There is a significant risk involved for investors in startups, but there is also the thrill of finding the “unicorn.” Unicorns are companies whose business model is so excellent that their value grows exponentially, resulting in an attractive payoff for investors.
VCs have become a prevalent tool for raising funds in recent times, and most of the companies applying are those with less than two years of experience under their belt. This is an excellent opportunity to raise funds and get experienced people on board so they can help the company out. On the other hand, it also means handing over at least some control to another person, which is almost inevitable when it comes to startup funding for business. In some situations, this can become confusing and occasionally troublesome, especially when ideas start to clash.
Angel investors could be considered a sub-genre of VCs. They help fund startup companies, while venture capitalists are more often than not professional investors who also provide hands-on guidance. Angel investors tend to be extremely wealthy individuals who see investing more as a hobby or a side-project rather than a full-time career. Angel investors are usually the first to jump on board a new project, while VCs typically come a bit later down the line.
These high-net-worth individuals who can provide significant funding for startups are usually entrepreneurs themselves, or people with CVs full of experience running business empires, which in some cases they’ve built themselves.
These individuals will likely invest in startups coming from a sector they are familiar with, as they know how to succeed in that field. They often look for just the basics in a company - they want it to be well-managed, ready for substantial growth, and to have a solid business plan. Just these metrics are commonly enough for angel investors to decide whether they will fund a particular company or not.
This type of early stage startup funding is excellent for small companies and those just starting their journey. If your business plan is valid and you manage your company well, angel investors will likely fund your startup and help you get it off the ground.
Banks are another valid option if you’re looking to get funds for your business, as they commonly provide small business loans for startups. This is a more traditional way to get the capital you need, but you’ll also face stricter requirements and a potentially tedious process to get there.
Unlike VCs and angel investors, who will occasionally invest even despite significant risks, banks are generally much more cautious when funding a startup business. This option is not ideal for small businesses that have no track record or revenue when asking for a loan, as they will likely get declined. If you’re in that situation, you might be better off turning to business credit cards for new businesses to cover some necessary expenses.
However, suppose your startup is taking off. In that case, you might want to consider a business loan instead of going to the VCs. Why? Because with this solution, you get to keep all the equity, which you would typically give away with other types of financing.
Still, make sure you’re taking the right loan, both in terms of size and APR. While there are undoubtedly many options when it comes to funding for startup companies, it’s important to select one that doesn’t come with prohibitive interest rates, as these could drive your business into the ground for a missed payment, especially if you have bad credit. Instead, look for those banks willing to provide loans even to companies with bad credit.
Crowdfunding is another method of raising the funds required to get your company started. This type of investing usually relies on people who are willing to more or less donate small amounts to a young business, which sends them prototypes of its product in return. The most notable websites in the crowdfunding niche are Kickstarter and Indiegogo.
Crowdinvesting, on the other hand, allows everyday people to invest in your company by purchasing equity offered in return for their investment. This is also known as equity crowdfunding. One can find a suitable startup funding platform online and purchase equity in a particular company for a small amount, and even earn shares of profit from the same company.
Nowadays you have a third option: crowdlending. The name explains it all; instead of going to the bank to get a loan applying for one of the credit cards available to small businesses, you can get the funds you need from multiple individuals looking to make a profit by lending you the funds you need.
These alternative options are excellent solutions for businesses that are having trouble receiving funding the traditional way or are just taking off and are looking to get startup funding as well as some new and hopefully long-term customers. These solutions tend to build communities around a project, something every small business can benefit from in the long run.
However, while these options provide support from the masses, they don’t give you the business experience that experienced investors can bring to the table, which is bound to make a difference in the long run.
Accelerators are, in all fairness, the ultimate combination of a social network and a business course. These are perfect for businesses that are in their very early stage and need some mentoring, not just funding. They help startups with practically everything, from helping create and join the relevant networks that will help them gain initial funding for a startup, to growing and expanding their business. Accelerators don’t necessarily include any investment, although some provide that on top of guidance.
These are often confused with incubators, as they have a similar purpose. However, incubators provide housing, whereas accelerators offer mentoring. These programs usually last anywhere from three to 12 months, throughout which the mentors focus on transferring their knowledge to a selected few startups.
Accelerators are often ideal for young startups that are yet to make an impact or are struggling to get basic funding. There are not many options for business loans for women or minorities, but accelerators offer an excellent opportunity for anyone to learn from the best, expand their network, and learn valuable tips and tricks that will help them grow and develop their business further in the future. If you’re lucky, you might find an accelerator that provides funding for startup businesses, which is a bonus on top of an already excellent deal.
Arguably the most tempting idea when it comes to getting funds for your startup is getting grant money. This money is usually offered to small companies and nonprofits, and the best part is that it doesn’t have to be repaid at all. With other funding options, startups have to keep in mind they will have to repay the money, set up collateral, or even pay interest, but grants for small business startups are essentially free money. And, let’s be honest, free money is a great solution for anyone who is wondering how to get funding for a startup.
Of course, free stuff tends to attract a crowd, and the competition for each grant is extraordinarily fierce. On top of that, there are usually strict limitations on how startups can use grant money if they succeed in getting it. If a startup doesn’t follow those limitations, the bosses can be ordered to pay the funds back or even found guilty of fraud.
Ultimately, it’s safe to say that acquiring a grant is the option that brings the most benefits, but is perhaps the hardest to get. Not many organizations offer grants in the first place, and even if you find one in your niche that could help you get funding for your startup, you’d need to fulfill some strict criteria, then use the money for a specific purpose. Occasionally, teams even hire specialists in the niche to help them get the grants, so it really is a challenging procedure.
You’ve probably heard of series A, B, and C funding, but you might not understand how this system differs from angel investors or VCs. The main difference is that series funding is usually for more advanced businesses with a fully established business model and a detailed business plan.
The overall funding process when it comes to startup series funding mostly depends on the type of business raising the money, as not all of them follow the same procedure. Startups are more likely to go with VCs and angel investors first, then follow the stream through series A, B, and C, alongside other types of additional funding if it’s required and appropriate.
However, series funding is almost inevitable for every successful company, especially for those entrepreneurs who dug deep into their pockets to fund the company and are now struggling to move forward due to a lack of funds.
Series A Funding
Series A funding is usually the next step for small business startup funding, mostly for startups that have established some track record but are yet to meet the parameters of being a small business. If the company has consistent revenue or other indicators suggesting that it’s performing successfully, it can pursue this type of funding. You’ll need to provide a detailed business plan emphasizing how the funding will help the business generate long-term profit; that could be by improving the product, developing new products, or expanding production.
To put it simply, this kind of funding requires more than just an idea. If you’re serious about getting series A funding, you’ll need a rock-solid strategy. Just consider that the average valuation of the companies going into a series A funding for startup business is as high as $23 million.
Typically, these series raise anywhere from $2 million to $15 million, although that number can be blown out of the water by unicorns and incredibly high tech industry valuations. In 2020, for example, the average series A funding was worth $15.6 million.
Where angel investors will jump on the opportunity to fund startups in their seed series, the funds for series A usually come from more traditional capital firms. In this scenario, politics play an important factor. The first investor, or the first investing company, is typically the one to set the tone, and it is easier to attract more investors after landing the first big fish. Angel investors, while crucial in the startup seed funding stage, don’t generally have such a strong influence.
Series B Funding
Series B funding typically comes when the team behind a company needs funds to expand. These companies already have substantial user bases and have proven that they can scale up and take their business to the next level. Demand also plays a crucial role in whether the company is ready for series B, as it dictates the need to expand.
As such, it’s not uncommon for series B to be all about hiring required people. Sales, marketing, tech, and other personnel cost a lot of money, which is where this startup funding round is genuinely beneficial.
Most companies going for series B funding are valued between $30 million and $60 million. However, there are some dramatically overvalued tech unicorns among them that push the average valuation up to $58 million. By comparison, the average value of funds raised in a regular series B is around $33 million.
In this series, the prominent investors are likely the same organizations or people who invested in series A. These investors tend to attract other investors looking to earn a profit from a successful company. This new wave of investors, especially ones who specialize in later-stage investing, differentiates this series.
Series C Funding
Series C isn’t really one of the typical startup funding stages, especially because to qualify for this round, you need to have a company rather than a startup. In other words, it’s usually reserved for companies that have already proven successful. Series C funding is commonly used to expand into new markets, purchase another company, or make another costly purchase. This series focuses on quickly scaling up the company to generate the highest profit as soon as possible.
Another important aspect of getting into series C is that the company has now proven that it is there to stay, so investors who were previously hesitant to get involved can now jump on the opportunity. Investing in a company that’s thriving is a low-risk but high-reward option, especially in this startup company funding round. In this series, hedge funds, investment banks, and even private equity firms tend to invest.
Series C is usually the last round of funding for most companies. Some of them go on to raise additional funds through series D and even occasionally E, but the expected next step is usually an IPO.
The average valuation of companies in this situation is around $118 million, though it could also be much higher. Unlike with previous rounds, this valuation is based on prior performance rather than estimations. The average amount of money raised through series C is $50 million in funding, making it the most valuable of all stages of startup funding.
IPOs are a dream come true for every startup, but only because that means the company already has a private valuation of approximately $1 billion and can get into the “process of offering shares of a private corporation to the public in a new stock issuance.”
The Long Haul
There’s a long and winding road ahead for any startup that’s looking for funding. There are funding opportunities at every startup stage, from pre-seed money all the way to launching an IPO, typically with several rounds of funding in between. Each of these startup funding opportunities will have its own set of requirements and will benefit your business in its own way.
How do I get funding for my startup?
Choosing which funding option you should aim for depends on which stage your startup is in. If you have an excellent idea but nothing more concrete than that, asking your family and friends for help is a good approach. If you already have something established, you might want to look for angel investors. You can also try crowdfunding options if your startup could benefit from alternative methods of startup financing.
What do startups use the funding for?
Most startup funding goes towards paying employees. On top of this, tech startups usually have other significant expenses like office space, hardware, servers, software, and legal fees.
What is the difference between funding and investment?
Funding is a term commonly used when someone is looking for money to support an idea or a project. Investing is the other side of the coin; it’s when an organization or individual who already has money is looking for a project that they can put some of that money into. Of course, they hope to benefit financially from the arrangement.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.
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